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Accounting Accounting Concepts and Concepts and

PrinciplesPrinciplesBy; Prof. Snawer GillBy; Prof. Snawer Gill

MS-Finance MS-Finance

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Introduction• Actually there are a number of

accounting concepts and principles based on which we prepare our accounts

• These generally accepted accounting principles (GAAP) lay down accepted assumptions and guidelines and are commonly referred to as accounting concepts

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Users of Financial Statements

• Investors– Need information about the profitability, dividend

yield and price earnings ratio in order to assess the quality and the price of shares of a company

• Lenders (Banks etc)– Need information about the profitability and solvency

of the business in order to determine the risk and interest rate of loans

• Management– Need information for planning, policy making and

evaluation• Suppliers and trade creditors

– Need information about the liquidity of business in order to access the ability to repay the amounts owed to them

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• Government– Need information about various businesses for

statistics and formulation of economic plan• Customers

– Interested in long-tem stability of the business and continuance of the supply of particular products

• Employees– Interested in the stability of the business to provide

employment, fringe benefits and promotion opportunities

• Public– Need information about the trends and recent

development

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Accounting Accounting ConceptsConcepts

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Business EntityBusiness Entity

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Business Entity• Meaning

– The business and its owner(s) are two separate existence entities (bodies)

– Any private and personal incomes and expenses of the owner(s) should not be treated as the incomes and expenses of the business

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• Examples– Insurance premiums for the owner’s

house should be excluded from the expense of the business

– The owner’s property should not be included in the premises account (Assets) of the business

– Any payments for the owner’s personal expenses by the business will be treated as drawings and reduced the owner’s capital contribution in the business

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Money MeasurementMoney Measurement

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Money Measurement• Meaning

– All transactions of the business are recorded in terms of money

– In accounting, the record of that transaction is made that is measurable into money.

• Examples•Value of assets and goods will be

recorded,• Wining of a price will not be

recorded

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Going ConcernGoing Concern

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Going Concern• Meaning

– The business will continue in operational existence for the foreseeable future

– Financial statements should be prepared on a going concern basis unless management either wants to dissolve the business.

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• Example – Owner of the business must provide

finance as needed to keep the business alive.

– Proverb “Sale a House for Shop”

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Historical CostHistorical Cost

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Historical Cost• Meaning

– Assets should be shown on the balance sheet at the cost of purchase instead of current value.

• Example– The cost of fixed assets is recorded at the

date of acquisition cost. – if business purchases a building for

Rs.500,000, it will be recorded in books at Rs. 500,000 even its market value at that time may be Rs. 600,000/-

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Prudence/Prudence/ConservatismConservatism

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Prudence/Conservatism • Meaning

– The prudence concept mean to prevent to be overstated. If profit is overstated, a trader may believe that his income is more than it really is, and he may withdraw too much money from business. That will decrease the capital injected in business.

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• Example– Stock valuation sticks to rule of the

lower of cost and net realizable value– The provision for doubtful debts

should be made– Fixed assets must be depreciated

over their useful economic lives

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MaterialityMateriality

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Materiality• Meaning

– Immaterial amounts may be aggregated with the amounts of a similar nature or function and need not be presented separately

– Materiality depends on the size and nature of the item

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• Example–Small payments such as postage, stationery and cleaning expenses should not be disclosed separately. They should be grouped together as sundry expenses

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ObjectivityObjectivity

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Objectivity• Meaning

– The accounting information should be free from bias and capable of independent verification

– The information should be based upon verifiable evidence such as invoices or contracts

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• Example– The recognition of revenue should be

based on verifiable evidence such as the delivery of goods or the issue of invoices

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Consistency Consistency (uniformity)(uniformity)

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Consistency• Meaning

– Companies should choose the most suitable accounting methods and treatments, and consistently apply them in every period

– Transactions of similar nature should be recorded in the same accounting and in all future accounting periods.

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• Examples– If a company adopts straight line

method and should not be changed to adopt reducing balance method in other period

• the cost of recording building should always be debited to expense account.

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Accruals/MatchingAccruals/Matching

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Accruals/Matching• Meaning

– Revenues are recognized when they are earned, but not when cash is received

– Expenses are recognized as they are incurred, but not when cash is paid

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• Example– Expenses incurred but not yet paid in

current period should be treated as accrual/accrued expenses under current liabilities

– Mr. A pays rent of Rs. 2000 per month. In November, he has paid Rs. 3,000, So, he will record rent expense as Rs. 2000.

November:Rent paid = 3,000Less prepaid = 1,000 2,000

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RealizationRealization

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Realization• Meaning• Revenues should be recognized

when the major economic activities have been completed

• Sales are recognized when the goods are sold and delivered to customers.

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Example;• Mr. Rana places an order to Mr. Gill for

supply of goods. But, goods are delivered by Mr. Gill in the next month. So, sales will be recorded at that time when goods are delivered and payment is made.

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Duality Duality (Dual Aspect (Dual Aspect

Concept)Concept)

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Relevance• Meaning

– This concept tell us that there are two aspects for each transaction represented by Dr and Cr, This concept is the basis of accounting equation;

assets = liabilities + capital

Example• Mr. Rana started business with

cash Rs. 30, 000;

Cash (assets) 30,000 to Capital (liability) 30,000 ___________________

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Substance over FormSubstance over Form

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Substance over Form• Meaning Substance over form is the

treatment according to the transaction. So that the real effect of the transaction on the business is recorded.

Example• A machine is purchased on hire

purchase (installment basis) remains the property of the seller until the final installment has been paid. If the purchaser fails to pay the installments, the seller may claim the machine.

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